MLP investors are especially wary of potential taxation changes because most have gone to considerable trouble to get comfortable with all the associated nuances of MLPs, such as distribution recapturing, recording basis, and filing Schedule K-1s. For this investment, handling these complexities is the price of admission.
President Trump has so far only released an outline of his new plan, and the Republican plan is also subject to change. Despite Trump’s optimism that tax reform will be completed this year, it could be into 2018—if not further out—when changes take effect. Still, since both plans include a reduction in the federal corporate tax rate from its current 35%, we will assess in broad strokes the potential changes with information that is currently available.
On newly forming companies
While the performance of any given set of assets is unaffected by the way the company is taxed, a management team may choose one structure over another based on potential competitive advantage. A company that forms as an MLP gains beneficial tax status but is also limited in scope. A lowered corporate tax rate also lowers the relative tax savings of the MLP structure, potentially leading to fewer new MLP IPOs.
While not addressed here, reductions in the individual income tax rate could also affect the desirability of the MLP structure to new companies.
On existing MLPs converting to C corporations
This is another version of the Kinder Morgan question: will more MLPs convert to C corporations?
Again, paying 0% in federal taxes is better than 15%, but since energy infrastructure companies are continually building assets and taking advantage of accelerated- depreciation accounting rules, their tax burden would already be quite low. That said, without the strictures of the MLP structure, they could opportunistically expand into businesses that are not currently permitted under the IRS rules, as well as benefit from a broader investor base (since most investors balk at receiving K-1s).
We also note there have already been three conversions to C corporations: Kinder Morgan Inc., SemGroup Corp. and Targa Resources Corp. A fourth was scheduled at press time, ONEOK Partners LP and parent ONEOK Inc.
On the MLP investor base
Under the current system, the Alerian MLP Index yields about 7%, the Standard & Poor’s 500 index yields about 2%, and utilities, about 3.5%. If the corporations in the S&P 500 or utilities pay less in taxes, they have more money available to distribute to shareholders. Holding all other factors equal, if the corporate tax rate dropped to 15%, the yield on the S&P 500 could move to 2.6%, and for utilities it could move to 4.6%.
That means there may be less yield-based demand for MLPs from a relative risk standpoint, especially for the income-focused portion of the MLP investor base.
At first blush, this is not encouraging. However, yield is not the only reason to own MLPs. The real asset exposure and participation in U.S. energy infrastructure remain unaffected by changes to the tax code.
At the same time, apathy resulting from a simplistic view that 0% is less than 15% is perhaps too relaxed. In fact, it’s possible that as yield-driven money turns its focus away from MLPs, smart money can again begin to influence valuations.
Maria Halmo is the director of research at Alerian, an independent provider of MLP and energy infrastructure market intelligence. At the end of May, more than $17 billion was directly tied to the Alerian Index Series. For additional commentary and research, please visit www.alerian.com/alerian-insights.
Recommended Reading
E&P Highlights: Feb. 12, 2024
2024-02-12 - Here’s a roundup of the latest E&P headlines, including more hydrocarbons found offshore Namibia near the Venus discovery and a host of new contract awards.
ChampionX to Acquire RMSpumptools, Expanding International Reach
2024-03-25 - ChampionX said it expects the deal to extend its reach in international markets including the Middle East, Latin America and other global offshore developments.
Triangle Energy, JV Set to Drill in North Perth Basin
2024-04-18 - The Booth-1 prospect is planned to be the first well in the joint venture’s —Triangle Energy, Strike Energy and New Zealand Oil and Gas — upcoming drilling campaign.
SLB to Buy Service Firm ChampionX in $7.7B All-stock Deal
2024-04-02 - SLB will acquire ChampionX for $7.74 billion in an all-stock deal that puts a 14.6% premium on ChampionX’s April 1 closing price.
Analysts, SLB Execs See Stability in $7.7B ChampionX Deal
2024-04-04 - The acquisition of ChampionX vaults SLB’s chemical production business to No. 1 globally and orients SLB's business toward resource recovery that is less tied to price volatility.